A. Field of the Invention
The present invention relates to a computer system and method for modeling and administrating a deferred award instrument plan.
B. Background of the Art
Increased competition among companies has led to the use of stock options as a tool to both recruit and maintain highly skilled labor. Stock options are used as a form of compensation that reward employees for their labor. Employer corporations grant employees the right to purchase stock in the employer at a fixed price. As new products or services are introduced and the stock price rises, the employee's stock options become more and more valuable. This option for example, may be given for past service or as incentive for future performance.
When stock options are granted, the price at which the employee has the right to purchase, the stock is referred to as the Grant Price. If the options are not exercised in a predetermined period of time, they often lapse. The difference between the Grant Price and the trade price of the stock in the appropriate exchange, (hereinafter "Market Price" of "FMV") is referred to as the Spread.
There are several different types of stock options that can be granted. Options may be Qualified, commonly referred to as Incentive Stock Options (ISO) that are governed by Sections 422 and 424 of the United States Tax Code. Options may also be Non-Qualified, commonly referred to as Non-Qualified Options (NSO).
There are numerous reasons why it is not desirable to issue too many stock options and/or have them exercised. First, the limited life of most options has cash liquidity ramifications on the employee. The selling of stock to cover stock option costs by key employees can have a negative impact on the company.
A second downside to stock options is taxes. If an NSO is exercised while the employee is alive, the Spread is immediately subject to ordinary income tax. For the stock that is held, the amount of appreciation over the Spread is subject to capital gains taxes when it is ultimately sold. The Spread on the stock that is not held and sold immediately upon exercise of the options is subject to ordinary income tax. Alternative minimum tax is applicable to the Spread of an ISO when it is exercised and capital gains tax is applicable on the difference between the Grant Price and the ultimate sales price of the stock.
If an NSO or ISO is not exercised when the employee is alive, the added burden of estate tax must also be computed. For example, an employee's family can expect to receive only 12% of the proceeds after taxes on a stock option that has a Market Value that is twice the grant price. The greater number of options awarded the larger the problem becomes. If an employee does not have enough cash to satisfy the Grant Price and taxes associated with an exercise, the employee is forced to sell stock, which only aggravates the tax consequences and reflects poorly on the company.